Thursday, 7 June 2012

New World Economy

A New World Economy

The balance of power will shift to the East as China and India evolve

It may not top the
must-see list of many tourists. But to appreciate Shanghai's ambitious
view of its future, there is no better place than the Urban Planning
Exhibition Hall, a glass-and-metal structure across from People's
Square. The highlight is a scale model bigger than a basketball court
of the entire metropolis -- every skyscraper, house, lane, factory,
dock, and patch of green space -- in the year 2020.

There are white
plastic showpiece towers designed by architects such as I.M. Pei and Sir
Norman Foster. There are immense new industrial parks for autos and
petrochemicals, along with new subway lines, airport runways, ribbons of
expressway, and an elaborate riverfront development, site of the 2010
World Expo. Nine futuristic planned communities for 800,000 residents
each, with generous parks, retail districts, man-made lakes, and nearby
college campuses, rise in the suburbs. The message is clear. Shanghai
already is looking well past its industrial age to its expected
emergence as a global mecca of knowledge workers. "In an information
economy, it is very important to have urban space with a better natural
and social environment," explains Architectural Society of Shanghai
President Zheng Shiling, a key city adviser.

It is easy to dismiss such dreams as bubble-economy hubris -- until
you take into account the audacious goals Shanghai already has achieved.
Since 1990, when the city still seemed caught in a socialist time warp,
Shanghai has erected enough high-rises to fill Manhattan. The
once-rundown Pudong district boasts a space-age skyline, some of the
world's biggest industrial zones, dozens of research centers, and a
bullet train. This is the story of China, where an extraordinary ability
to mobilize workers and capital has tripled per capita income in a
generation, and has eased 300 million out of poverty. Leaders now are
frenetically laying the groundwork for decades of new growth.

INVALUABLE ROLE
Now hop a plane to India. It is hard to tell this is the world's other
emerging superpower. Jolting sights of extreme poverty abound even in
the business capitals. A lack of subways and a dearth of expressways
result in nightmarish traffic.

But visit the office towers and research and development centers
sprouting everywhere, and you see the miracle. Here, Indians are playing
invaluable roles in the global innovation chain. Motorola, (MOT
) Hewlett-Packard (HPQ
), Cisco Systems (CSCO
), and other tech giants now rely on their Indian teams to devise
software platforms and dazzling multimedia features for next-generation
devices. Google (GOOG
) principal scientist Krishna Bharat is setting up a Bangalore lab
complete with colorful furniture, exercise balls, and a Yamaha organ --
like Google's Mountain View (Calif.) headquarters -- to work on core
search-engine technology. Indian engineering houses use 3-D computer
simulations to tweak designs of everything from car engines and
forklifts to aircraft wings for such clients as General Motors Corp. (GM
) and Boeing Co (BA
). Financial and market-research experts at outfits like B2K,
OfficeTiger, and Iris crunch the latest disclosures of blue-chip
companies for Wall Street. By 2010 such outsourcing work is expected to
quadruple, to $56 billion a year.

Even more exhilarating is the pace of innovation, as tech hubs like
Bangalore spawn companies producing their own chip designs, software,
and pharmaceuticals. "I find Bangalore to be one of the most exciting
places in the world," says Dan Scheinman, Cisco Systems Inc.'s senior
vice-president for corporate development. "It is Silicon Valley in
1999." Beyond Bangalore, Indian companies are showing a flair for
producing high-quality goods and services at ridiculously low prices,
from $50 air flights and crystal-clear 2 cents-a-minute cell-phone
service to $2,200 cars and cardiac operations by top surgeons at a
fraction of U.S. costs. Some analysts see the beginnings of
hypercompetitive multinationals. "Once they learn to sell at Indian
prices with world quality, they can compete anywhere," predicts
University of Michigan management guru C.K. Prahalad. Adds A. T. Kearney
high-tech consultant John Ciacchella: "I don't think U.S. companies
realize India is building next-generation service companies."

SIMULTANEOUS TAKEOFFS
China and India. Rarely has the economic ascent of two still relatively
poor nations been watched with such a mixture of awe, opportunism, and
trepidation. The postwar era witnessed economic miracles in Japan and
South Korea. But neither was populous enough to power worldwide growth
or change the game in a complete spectrum of industries. China and
India, by contrast, possess the weight and dynamism to transform the
21st-century global economy. The closest parallel to their emergence is
the saga of 19th-century America, a huge continental economy with a
young, driven workforce that grabbed the lead in agriculture, apparel,
and the high technologies of the era, such as steam engines, the
telegraph, and electric lights.

But in a way, even America's rise falls short in comparison to what's
happening now. Never has the world seen the simultaneous, sustained
takeoffs of two nations that together account for one-third of the
planet's population. For the past two decades, China has been growing at
an astounding 9.5% a year, and India by 6%. Given their young
populations, high savings, and the sheer amount of catching up they
still have to do, most economists figure China and India possess the
fundamentals to keep growing in the 7%-to-8% range for decades.

Barring cataclysm, within three decades India should have vaulted
over Germany as the world's third-biggest economy. By mid-century, China
should have overtaken the U.S. as No. 1. By then, China and India could
account for half of global output. Indeed, the troika of China, India,
and the U.S. -- the only industrialized nation with significant
population growth -- by most projections will dwarf every other economy.

What makes the two giants especially powerful is that they complement
each other's strengths. An accelerating trend is that technical and
managerial skills in both China and India are becoming more important
than cheap assembly labor. China will stay dominant in mass
manufacturing, and is one of the few nations building
multibillion-dollar electronics and heavy industrial plants. India is a
rising power in software, design, services, and precision industry. This
raises a provocative question: What if the two nations merge into one
giant "Chindia?" Rival political and economic ambitions make that
unlikely. But if their industries truly collaborate, "they would take
over the world tech industry," predicts Forrester Research Inc (FORR
). analyst Navi Radjou.

In a practical sense, the yin and yang of these immense workforces
already are converging. True, annual trade between the two economies is
just $14 billion. But thanks to the Internet and plunging telecom costs,
multinationals are having their goods built in China with software and
circuitry designed in India. As interactive design technology makes it
easier to perfect virtual 3-D prototypes of everything from telecom
routers to turbine generators on PCs, the distance between India's
low-cost laboratories and China's low-cost factories shrinks by the
month. Managers in the vanguard of globalization's new wave say the
impact will be nothing less than explosive. "In a few years you'll see
most companies unleashing this massive productivity surge," predicts
Infosys Technologies (INFY
) CEO Nandan M. Nilekani.

To globalization's skeptics, however, what's good for Corporate
America translates into layoffs and lower pay for workers. Little
wonder the West is suffering from future shock. Each new Chinese
corporate takeover bid or revelation of a major Indian outsourcing deal
elicits howls of protest by U.S. politicians. Washington think tanks are
publishing thick white papers charting China's rapid progress in
microelectronics, nanotech, and aerospace -- and painting dark scenarios
about what it means for America's global leadership.

Such alarmism is understandable. But the U.S. and other established
powers will have to learn to make room for China and India. For in
almost every dimension -- as consumer markets, investors, producers, and
users of energy and commodities -- they will be 21st-century
heavyweights. The growing economic might will carry into geopolitics as
well. China and India are more assertively pressing their interests in
the Middle East and Africa, and China's military will likely challenge
U.S. dominance in the Pacific.

One implication is that the balance of power in many technologies
will likely move from West to East. An obvious reason is that China and
India graduate a combined half a million engineers and scientists a
year, vs. 60,000 in the U.S. In life sciences, projects the McKinsey
Global Institute, the total number of young researchers in both nations
will rise by 35%, to 1.6 million by 2008. The U.S. supply will drop by
11%, to 760,000. As most Western scientists will tell you, China and
India already are making important contributions in medicine and
materials that will help everyone. Because these nations can throw more
brains at technical problems at a fraction of the cost, their
contributions to innovation will grow.

CONSUMERS RISING
American business isn't just shifting research work because Indian and
Chinese brains are young, cheap, and plentiful. In many cases, these
engineers combine skills -- mastery of the latest software tools, a
knack for complex mathematical algorithms, and fluency in new multimedia
technologies -- that often surpass those of their American
counterparts. As Cisco's Scheinman puts it: "We came to India for the
costs, we stayed for the quality, and we're now investing for the
innovation."

A rising consumer class also will drive innovation. This year,
China's passenger car market is expected to reach 3 million, No. 3 in
the world. China already has the world's biggest base of cell-phone
subscribers -- 350 million -- and that is expected to near 600 million
by 2009. In two years, China should overtake the U.S. in homes connected
to broadband. Less noticed is that India's consumer market is on the
same explosive trajectory as China five years ago. Since 2000, the
number of cellular subscribers has rocketed from 5.6 million to 55
million.

What's more, Chinese and Indian consumers and companies now demand
the latest technologies and features. Studies show the attitudes and
aspirations of today's young Chinese and Indians resemble those of
Americans a few decades ago. Surveys of thousands of young adults in
both nations by marketing firm Grey Global Group found they are
overwhelmingly optimistic about the future, believe success is in their
hands, and view products as status symbols. In China, it's fashionable
for the upwardly mobile to switch high-end cell phones every three
months, says Josh Li, managing director of Grey's Beijing office,
because an old model suggests "you are not getting ahead and updated."
That means these nations will be huge proving grounds for
next-generation multimedia gizmos, networking equipment, and wireless
Web services, and will play a greater role in setting global standards.
In consumer electronics, "we will see China in a few years going from
being a follower to a leader in defining consumer-electronics trends,"
predicts Philips Semiconductors (PHG
) Executive Vice-President Leon Husson.

For all the huge advantages they now enjoy, India and China cannot
assume their role as new superpowers is assured. Today, China and India
account for a mere 6% of global gross domestic product -- half that of
Japan. They must keep growing rapidly just to provide jobs for tens of
millions entering the workforce annually, and to keep many millions more
from crashing back into poverty. Both nations must confront ecological
degradation that's as obvious as the smog shrouding Shanghai and Bombay,
and face real risks of social strife, war, and financial crisis.

Increasingly, such problems will be the world's problems. Also, with
wages rising fast, especially in many skilled areas, the cheap labor
edge won't last forever. Both nations will go through many boom and
harrowing bust cycles. And neither country is yet producing companies
like Samsung, Nokia (NOK
), or Toyota (TM
) that put it all together, developing, making, and marketing world-beating products.

Both countries, however, have survived earlier crises and possess
immense untapped potential. In China, serious development only now is
reaching the 800 million people in rural areas, where per capita annual
income is just $354. In areas outside major cities, wages are as little
as 45 cents an hour. "This is why China can have another 20 years of
high-speed growth," contends Beijing University economist Hai Wen.

Very impressive. But India's long-term potential may be even higher.
Due to its one-child policy, China's working-age population will peak at
1 billion in 2015 and then shrink steadily. China then will have to
provide for a graying population that has limited retirement benefits.
India has nearly 500 million people under age 19 and higher fertility
rates. By mid-century, India is expected to have 1.6 billion people --
and 220 million more workers than China. That could be a source for
instability, but a great advantage for growth if the government can
provide education and opportunity for India's masses. New Delhi just now
is pushing to open its power, telecom, commercial real estate and
retail sectors to foreigners. These industries could lure big capital
inflows. "The pace of institutional changes and industries being
liberalized is phenomenal," says Chief Economist William T. Wilson of
consultancy Keystone Business Intelligence India. "I believe India has a
better model than China, and over time will surpass it in growth."

For its part, China has yet to prove it can go beyond forced-march
industrialization. China directs massive investment into public works
and factories, a wildly successful formula for rapid growth and job
creation. But considering its massive manufacturing output, China is
surprisingly weak in innovation. A full 57% of exports are from
foreign-invested factories, and China underachieves in software, even
with 35 software colleges and plans to graduate 200,000 software
engineers a year. It's not for lack of genius. Microsoft Corp.'s (MSFT
) 180-engineer R&D lab in Beijing, for example, is one of the
world's most productive sources of innovation in computer graphics and
language simulation.

While China's big state-run R&D institutes are close to the
cutting edge at the theoretical level, they have yet to yield many
commercial breakthroughs. "China has a lot of capability," says
Microsoft Chief Technology Officer Craig Mundie. "But when you look
under the covers, there is not a lot of collaboration with industry."
The lack of intellectual property protection, and Beijing's heavy role
in building up its own tech companies, make many other multinationals
leery of doing serious R&D in China.

China also is hugely wasteful. Its 9.5% growth rate in 2004 is less
impressive when you consider that $850 billion -- half of GDP -- was
plowed into already-glutted sectors like crude steel, vehicles, and
office buildings. Its factories burn fuel five times less efficiently
than in the West, and more than 20% of bank loans are bad. Two-thirds of
China's 1,300 listed companies don't earn back their true cost of
capital, estimates Beijing National Accounting Institute President Chen
Xiaoyue. "We build the roads and industrial parks, but we sacrifice a
lot," Chen says.

India, by contrast, has had to develop with scarcity. It gets scant
foreign investment, and has no room to waste fuel and materials like
China. India also has Western legal institutions, a modern stock market,
and private banks and corporations. As a result, it is far more
capital-efficient. A BusinessWeek analysis of Standard & Poor's (MHP
) Compustat data on 346 top listed companies in both nations shows
Indian corporations have achieved higher returns on equity and invested
capital in the past five years in industries from autos to food
products. The average Indian company posted a 16.7% return on capital in
2004, vs. 12.8% in China.

SMALL-BATCH EXPERTISE
The burning question is whether India can replicate China's mass
manufacturing achievement. India's info-tech services industry,
successful as it is, employs fewer than 1 million people. But 200
million Indians subsist on $1 a day or less. Export manufacturing is one
of India's best hopes of generating millions of new jobs.

India has sophisticated manufacturing knowhow. Tata Steel is among
the world's most-efficient producers. The country boasts several top
precision auto parts companies, such as Bharat Forge Ltd. The world's
biggest supplier of chassis parts to major auto makers, it employs 1,200
engineers at its heavily automated Pune plant. India's forte is
small-batch production of high-value goods requiring lots of
engineering, such as power generators for Cummins Inc. (CMI
) and core components for General Electric Co. (GE
) CAT scanners.

What holds India back are bureaucratic red tape, rigid labor laws,
and its inability to build infrastructure fast enough. There are hopeful
signs. Nokia Corp. is building a major campus to make cell phones in
Madras, and South Korea's Pohang Iron & Steel Co. plans a $12
billion complex by 2016 in Orissa state. But it will take India many
years to build the highways, power plants, and airports needed to rival
China in mass manufacturing. With Beijing now pushing software and
pledging intellectual property rights protection, some Indians fret
design work will shift to China to be closer to factories. "The question
is whether China can move from manufacturing to services faster than we
can solve our infrastructure bottlenecks," says President Aravind
Melligeri of Bangalore-based QuEST, whose 700 engineers design gas
turbines, aircraft engines, and medical gear for GE and other clients.

However the race plays out, Corporate America has little choice but
to be engaged -- heavily. Motorola illustrates the value of leveraging
both nations to lower costs and speed up development. Most of its
hardware is assembled and partly designed in China. Its R&D center
in Bangalore devises about 40% of the software in its new phones. The
Bangalore team developed the multimedia software and user interfaces in
the hot Razr cell phone. Now, they are working on phones that display
and send live video, stream movies from the Web, or route incoming calls
to voicemail when you are shifting gears in a car. "This is a very,
very critical, state-of-the-art resource for Motorola," says Motorola
South Asia President Amit Sharma.

Companies like Motorola realize they must succeed in China and India
at many levels simultaneously to stay competitive. That requires
strategies for winning consumers, recruiting and managing R&D and
professional talent, and skillfully sourcing from factories. "Over the
next few years, you will see a dramatic gap opening between companies,"
predicts Jim Hemerling, who runs Boston Consulting Group's Shanghai
practice. "It will be between those who get it and are fully mobilized
in China and India, and those that are still pondering."

In the coming decades, China and India will disrupt workforces,
industries, companies, and markets in ways that we can barely begin to
imagine. The upheaval will test America's commitment to the global trade
system, and shake its confidence. In the 19th century, Europe went
through a similar trauma when it realized a new giant -- the U.S. -- had
arrived. "It is up to America to manage its own expectation of China
and India as either a threat or opportunity," says corporate strategist
Kenichi Ohmae. "America should be as open-minded as Europe was 100 years
ago." How these Asian giants integrate with the rest of the world will
largely shape the 21st-century global economy.